lisa: from new york city for viewers worldwide, i'm lisa abramowicz in for jonathan ferro. with 30 minutes dedicated to fixed income. this is "bloomberg real yield." coming up, the selloff in emerging markets is roiling debt investors. how far will it go? plus, the flattening treasury yield curve is raising alarm bells. is the u.s. economy vulnerable? and italian bond investors run for cover ahead of what is potentially another month of political turmoil.

we start with the big issue, pain in emerging markets. >> emerging markets has been hit quite hard. >> global liquidity is actually on the retreat. that will definitely leave traces in emerging markets. >> some of them are in good shape, some of them are not. they are all being tarred by the same brush. what that means is investors who are careful about looking for the nuggets are going to find some really good opportunities. >> we do see some selective value there. what has hurt the emerging markets has been the strong dollar and the fed tightening and higher u.s. interest rates that has caused capital to move out of emerging markets into the u.s. but the point is that a lot of the dollar strength, most of it, who knows when the dollar will peak, but a lot of that has happened. >> we will see points in time where investors start splitting their interest between the good, bad, and ugly with regard to emerging markets. >> don't forget emerging markets. emerging markets benefit from two things, they benefit from accelerating global growth and

they benefit from commodities because many of them are commodity producers. when emerging-market shares are this cheap, i think it is silly not to look for value in emerging markets. that is what we are doing. lisa: joining me around the table in new york is priya misra, head of global rate strategy at tc securities, and michael collins, a senior portfolio manager. plus, ian staley from jpmorgan. ian, i want to start with you since you are closer to these nations that are in turmoil right now. do you see opportunities here in emerging markets, or are you seeing contagion that will only escalate? iain: i think you really need to split the emerging markets apart. we obviously have seen big contagion in the argentinas and turkeys of this world. that has reverberated around the whole of the emerging economies.

some of them are in good health, whether it is mexico with the improvement on nafta, central european economies that are doing well on the back of the eurozone. i think actually, there are pockets of value to be had. it is a case of knuckling down and doing the research and finding those and trying to avoid the pitfalls out there. lisa: mike, avoiding the pitfalls, let's talk about one called argentina, where the yield has been blowing out relative to the u.s. treasury yield. are you buying argentina right now? michael: we are overweight argentina. their bonds look really cheap. their hard currency debt is trading over 800 basis points in spread. not that long ago, they were the poster child for reform-oriented emerging markets. they were doing all the right things, they had a reformist government. they just had some problems. seems like the bond market and currency market vigilantes, not to mention the imf, are forcing fiscal discipline on them. i think ultimately, it works out in argentina. lisa: is this the fed's fault?

priya: i think there is a fed component. ecb, boj, they are retreating. you have this liquidity that is coming out of the system. when you have them giving you more than 2%, you should reprice your premium elsewhere. i think part of this p.m. thing is absolutely quantitative tightening. even the rate market reaction to e.m. has changed. earlier on, it was being viewed as more idiosyncratic. in the last month, the markets are saying, maybe the fed can't hike that much. i think the rate market is saying this is more than argentina or turkey, this is systemic. this has the chance of potentially slowing the fed hiking cycle. lisa: this is contagion, this is problematic. iain, i want to get your thoughts. you said you see opportunities and need to dig in there, do fundamental research. what are you doing with your portfolio? are you buying mexican bonds and bonds of other places? if so, is corporate debt, sovereigns, what are you doing? iain: we are looking for the

areas we like, we like areas like mexico. we have been adding areas like that in the portfolio. we have yields up high for the year. obviously the peso has rallied a lot since nafta talks. it seems to have stabilized. an attractive yield. if you look at the hungarian yield curve, it is very steep. those yields should be anchored somewhat to what the ecb is doing. as was mentioned, the ecb is doing quantitative tightening, but they are not raising rates anytime soon. that means there will be this zero-rate interest policy across europe. that will attract investors who are looking for yield. lisa: michael, one thing i am struck by is the yield investors are able to get from emerging markets relative to u.s. high-yield corporate bonds. it is quite substantial. it perhaps has to do with the high valuations in the u.s. where do you see the value between those? michael: i know we will get into corporate credit later in the show in general. but, we have been reducing

exposure to corporate credit globally. u.s. high-yield, european high-yield, investment grade, credit globally, especially industrials, non-banks. emerging markets, because of the relative yield and spread attractiveness of emerging markets -- granted, they are underperforming as we sit here, but they look more attractive on eighth your relative -- on a pure relative value basis. many countries are doing the right aims and look pretty good and don't have a lot of external debt. brazil, to some extent, has little government external debt. and mexico, with the nafta thing, could be a bright spot. there is value that has been created in emerging markets. on the hard currency side, but also on the local currency side. these rates are high and the currencies have gotten killed. lisa: have you been reducing your allocation to u.s. credit and increasing to emerging markets? michael: we have been cutting credit risk in general. spread risk, credit risk. we have been reducing the corporate side. we have not been cutting the emerging markets.

the kind of let that on a relative basis become better. we have not started adding aggressively. maybe that time will happen soon. lisa: what are you adding instead of corporate credit across the board? michael: some of it is high-quality sovereign debt. treasuries. but structured product is one of our favorite trades. clo's, kind of esoteric stuff. commercial mortgage-backed securities. those look really cheap to us. those are new risk-free assets. lisa: mike is adding treasuries. i am wondering, from where you sit, do you see yields on the longer end continuing to decline relative to short ends? will we get a yield curve inversion sooner than later? priya: inversion, we are a little bit away from. i think the curve will continue to flatten. the biggest risk around the flatten, the fed will continue to hike rates. the market has priced for some

of it. i think the fed could hike faster than what is priced in. that can move the front end higher. the long in stays anchored because of global rates. that is the reason for the continued flattening. inversion is a different story. i think for inversion, you need the fed to go above neutral. if the fed is taking the fund rate above 3%, they need an inverted curve. lisa: we have a steady range that the treasury has traded in over the past quarter. the next move, up higher or lower? priya: i think higher, just given we are near the low end of the range. we have been looking for the 3% all year as being a ceiling on the 10 year. lisa: a little bit higher, but not much. everyone is sticking with me. priya misra, michael collins, and iain stealey. coming up, the auction block. u.s. high-yield issuance dries up in august. this is "bloomberg real yield." ♪

lisa: i'm lisa abramowicz in for jonathan ferro. this is "bloomberg real yield." i want to head to the auction block, where the u.s. treasury auctioned off more than $280 billion this week. we focus on the seven-year sale. the bid to cover was 2.65, marking the highest demand since january. the primary dealer take was roughly the years average. looking closer at the short end, the two-year sale of $36 billion had a yield of 2.65%. and a bid to cover of 2.89%. over in corporate, much, much quieter. u.s. junk bonds had no prices or launches to speak of. issuance so far this year is the to date total

since 2010. still with me is priya misra, michael collins, and iain stealey. i want to turn to europe. the eyes are all on italy. iain, you are in europe, let's start with you. we are focusing on the fact that bonds have climbed to the highest since 2014, and the gap -- bunds and italian yields has climbed to the highest since 2013. what is going on? iain: i think there's a couple of things going on. you have this general risk off sentiment that is starting with emerging markets and it is feeding its way into asset classes. that is the first thing. second, there is a liquidity premium for italian government bonds. you can't trade the size we were looking at earlier in the year. the most important of all, people are looking into september and looking at what the announcements are going to be around the fiscal side and how much additional spending the italians want to get out there.

what is interesting is we are back at levels, as you mentioned, the highest we have seen for a while. back to where we were in april, may time when we first got all these concerns regarding italy. we are in a much better place, though, from the mood music we are hearing out of the italians. at the time, we were discussing a 7%, 8% deficit. there were talks about a euro breakup. i think we could see the italian governments do pretty well over the next couple of months if we see good news on the fiscal side. lisa: what is your sense? priya: i would agree. the market was so complacent about italy. the market has been extremely nervous about italy. some of the recent comments we have had, they have said, we don't really want to take the debt to gdp higher. the markets putting pressure on italy here. they will have to come up with a budget that does not entirely breach all the eu rules. given what is priced in, i would say maybe positive news around italy is expected.

but it is uncertain. michael: the spreads on italy, looking at the chart, almost 300 over bunds, it looks pretty cheap. the spread curve is relatively flat. it is flattening today. the front end is selling off more. similar to what we are seeing in argentina. inverted type spread curves. short italy seems attractive on a relative basis. the bond market -- lisa: to be clear, short-term debt of italy, not trying to short italian debt. got it. michael: i don't think they will go bankrupt in the next four years as a country. they have been around a long time. lisa: timestamp. i don't think they will go bankrupt. you are adding on the short end. michael: we were overweight, yes. lisa: you have been actively maneuvering? michael: we like the front end. lisa: have you been adding? iain: i completely agree with michael on this. if you look at the front end, the breakeven is there. very compelling. you can get yield spreads well

above where you can get most other short-dated fixed income instruments across europe and particularly compared to where cash is. cash in europe is still negative. lisa: you did mention liquidity. i do have to wonder at what point is liquidity in european markets sufficient to max out some of these wagers? if everybody moves in one direction or an italian bank runs into trouble, how vulnerable are you? how is liquidity? iain: i think liquidity has been challenged. it has been challenged because we are in the summer holidays. and also because we are coming to the end of the ecb's bond buying program. what is a good sign for italy is we had one of the strongest five-year auctions on record. a huge interest in the market. that's why people are looking at these markets thinking if i want to get allegations to these markets, i need to go to the new issue market where you can get the size i am after. lisa: i would love to get your sense.

heading into the next year end, where is the action going to be? it sounds like there is a consensus around the table that we will get lower italian bond yields. what about german bunds? are those yields going to rise? priya: i think we can get to 60, 65 basis points. i think that can help u.s. treasuries go up. i think about that does need the ecb here to talk about hikes. i think we have an ecb leadership change coming up. i don't think the ecb is seeing a lot of inflation. that's what i think even bunds are capped. as much as i would like to tell you about the basis point selloff happening here, i think it is 20, 30 basis points in bunds in treasuries, i think it could be interesting. and the boj -- lisa: real yield! priya: the boj is actually trying to inject a little bit of volatility in the market. can they gap it at 20 basis points, or can they not?

if they start rising, we have a bigger global route. we're not looking for that, but that is a risk factor. lisa: where is the big excitement going to be going into the end of the year? iain: i think it could well be in the emerging markets. i think that is where we could see some volatility, but also see decent returns. i would say on the german, on the core government rates, i think we could see yields push a little bit higher over the course of the back end of this year. although when i look at germany, i agree. you are capped by what the ecb is doing on the cash rate is not going anywhere. lisa: where will you be? michael: one trade we like is the relative yield between u.s. and germany. sometimes it is easier to pick relative yields than absolute yields. i think those yields will compress over time. lisa: everyone is sticking with me. priya misra, michael collins, and in london, iain stealey from jpmorgan asset management. let's get a market check on where bonds have been this week. not doing too much. yields tipping higher on the front end.

a little bit bigger of a selloff on the back end with 10 year and 30 year treasury yields rising four basis points. still ahead, the final spread. the week ahead features the u.s. jobs report and potentially another round of tariffs between the u.s. and china. this is "bloomberg real yield." ♪

lisa: i'm lisa abramowicz in for jonathan ferro. this is "bloomberg real yield." time for the final spread, coming up over the next week, u.s. markets will be closed on monday due to labor day. during the week, we will hear from the boe's mark carney. bank of canada will make a rate decision. and we will get the u.s. jobs report and potentially another round of tariffs. still with me is priya misra, michael collins, and iain stealey. i want to end with what your

highest conviction contrarian bets are heading into the year. priya, i want to start with you. priya: i will combine two things. i will say lower rates and higher vol. interest rate volatility is at all-time lows. i think most people expect interest rates to rise. hikee do expect the fed to in september and december. if you buy the combination of an auction, and should make the trade work, as well as lower rates, i think the risk around em, risk around tariffs, all of that can potentially make rates drop as well as vol pickup. it is a combination. lisa: when you say rates, are you talking 30-year, 10-year treasury yields? priya: i would say 10-year. lisa: mike? michael: i will go with the theme of two ideas. one is lower rates. i believe we have been in that tight range. if you have a breakout in one direction, feels like the higher probability is on the downside.

but emerging markets, which we have talked about today, could be a star performer. lisa: including turkey and argentina? michael: possibly. lisa: iain, what is your highest conviction contrarian bet? iain: everyone else has had two. i will take two as well. i will agree on the emerging markets high. i am looking at these returns down 5% on the hard currency, down 10% on local bonds. i would not be surprised if we are close to flat on the end of the year. i think we can recoup a lot of those losses. the other thing i think we're looking at is the underperformance of european high yields relative to u.s. high yield over the course of this year. i think that can reverse as well . i think the european high-yield market, those spreads look pretty attractive to us, given the positive corporate fundamentals going on in europe and the fact that you will continue to see the zero interest rate policy which will force people to look at these sorts of corporations to grab yield. lisa: mike, you're nodding, do you agree? michael: we have looked at the relative value differential

between u.s. and europe, and that does jump out at us a little bit. of buyingthe margin european high-yield to u.s. high-yield. lisa: i would love to get a sense of whether the u.s. credit markets in general are overheating or getting a little bit stretched. ford just downgraded to one level above junk. this is an automaker with nearly $90 billion of debt. a big issuer. mike, how significant would it be if it did get downgraded? what does it say about the state of where we are at? michael: i was in the heart of the high-yield market 15 years ago. i went through the general motors and ford downgrade into junk. we spent months and years looking at that and analyzing it. it turned out it was so well-telegraphed it did not have an impact on the rest of the high-yield market. if ford ends up being the tip of the iceberg and you have multiple downgrades, fallen angels of investment-grade companies with big capital structures into the high-yield

market, that obviously reprices spreads further. lisa: priya, if you expect lower yields, what does it say about the state of the u.s. economy at a time when equities are doing well and economic data seems to be on the tear? priya: i think on the credit point, it if i think about corporate profits, they are at record highs. the corporate sector looks very strong. the entire spending plan for february will hit us in 2019. we still have that. it will help the corporate sector. you could have some idiosyncratic corporate issues. but i think overall, the u.s. economy is on fire. lisa: do you think right now investors are underpricing the european economy? and the strength of it? iain: i think that is a possibility. if you look at some of the numbers we have had out, specifically in germany and france, they have been strong. we have seen weakness in the

peripheral data, spain and italy. spain is coming off a very high base. obviously we have all the noise the have spoken about already around italy. i would not be surprised if you see a bit of strength come through from the whole of europe over the second half of this year. that is maybe one of the catalysts that pushes bund yields back up toward 50 basis points. lisa: time for rapid fire. this time next year, would you or greecen italy 10-year bonds? priya: italy. michael: greece. iain: i will take greece. lisa: will u.s. 10-year yields be closer to 2.5% or 3% by year-end? iain: above 3%. michael: closer to 3%. priya: 3%. lisa: when will the u.s. yield curve invert, six months or 12 or more months? priya: six months. michael: 12 or more.

iain: 12 or more. lisa: really? really quick, you care about the yield curve. or is this time different? priya: i care. michael: yes. i think the fed is whistling past the graveyard. i think a flatter yield curve is a big deal. iain: i think the curve continues to flatten off. but i think this time is a bit different compared to everything else going on around the rest of the world. lisa: my thanks to priya misra, michael collins, and iain stealey. from new york, that does it for us. we will see you next friday at 1:00 p.m. new york time. 6:00 p.m. in london. this is "bloomberg real yield." ♪

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